How you help Facebook make billions

By Doug Gross, CNN

Updated 5:57 PM ET, Wed May 16, 2012

Chat with us in Facebook Messenger. Find out what's happening in the world as it unfolds.

Photos:

8 years of Facebook highlights – It all began in a Harvard dorm room in 2004. Mark Zuckerberg and fellow students Dustin Moskovitz, Chris Hughes and Eduardo Saverin start what then was known as Thefacebook. The social-networking site spreads to other Ivy League universities the next month.

Hide Caption

1 of 12

Photos:

June 2004 – Zuckerberg and his partners move Facebook's base of operations to Palo Alto, California, where they meet former Napster co-founder Sean Parker. The savvy, hard-partying Parker becomes an early partner (and later president) of Facebook and helps attract investors to the fledgling network.

Hide Caption

2 of 12

Photos:

September 2005 – The company drops the "the" from its name after Parker pays $200,000 for Internet address Facebook.com. Facebook has grown to include students from more than 1,000 colleges and universities and is opening to high schools.

Hide Caption

3 of 12

Photos:

September 2006 – Facebook opens to anyone older than 13 with a valid e-mail address. That same month, the site introduces its News Feed, which highlights updates, photos, etc., from friends within your network. Users revolt, starting petitions to change Facebook back, although -- as with most Facebook changes -- they eventually grow to embrace the feature.

Hide Caption

4 of 12

Photos:

October 2007 – Microsoft purchases a 1.6% share of Facebook for $240 million, valuing the company at about $15 billion. The deal comes after other Internet giants, including Google and Yahoo, failed to buy all or part of Facebook. By now, more than half the site's users live outside the United States.

Hide Caption

5 of 12

Photos:

August 2008 – Facebook hits 100 million users. The same year, it surpasses MySpace to become the world's most popular social network.

Hide Caption

6 of 12

Photos:

September 2009 – One month after acquiring rival network FriendFeed, Zuckerberg announces Facebook has begun turning a profit for the first time.

Hide Caption

7 of 12

Photos:

April 2010 – Facebook introduces the Like button, which is quickly adopted by the thousands of news and retail sites that integrate with the social network. Some users complain there should be a "Dislike" button, too. Despite growing user concerns over privacy, Facebook hits half a billion users three months later.

Hide Caption

8 of 12

Photos:

October 2010 – "The Social Network," David Fincher's movie about the founding of Facebook, hits theaters, making Mark Zuckerberg a household name. The film is a critical and commercial hit, earning $225 million worldwide and winning three Oscars. Zuckerberg calls the movie a largely inaccurate dramatization but says it gets his casual wardrobe right.

Hide Caption

9 of 12

Photos:

December 2011 – Facebook rolls out Timeline, a redesign to the site's user profile pages, amid ever-present complaints about the changes. But Zuckerberg's not worried -- by this time the site has 800 million active users, half of whom log in every day.

May 2012 – Facebook prepares to become a publicly traded company, raising billions of dollars from investors. The company says it expects to price its shares at $34 to $38 each, potentially valuing Facebook at more than $100 billion. Based on his stake, Zuckerberg himself will likely be worth more than $15 billion.

Hide Caption

12 of 12

Story highlights

Facebook's multibillion-dollar business model relies on user data

Experts say the social network's targeted advertising can be uniquely precise

If you have a Facebook account, the company values you at $4.84 a year

Every post you "like." Every friend you add or fan page you join. Every place you check in, and every Web page you recommend.

To you, those are ways to enjoy, expand and improve your experience on Facebook. To Facebook, they're the building blocks of a multibillion-dollar company.

In business, there's a well-worn line that could apply to the social-networking behemoth: If you're not paying for it, you're not the customer. You're the product.

In this case, you're a product worth, to Facebook, an average $4.84 a year.

As Facebook hits Wall Street this week with a public stock offering that could value the company at more than $100 billion, investors appear dazzled by the company's uncannyability to put the right advertisements in front of its roughly 900 million users.

"The unique thing about these guys is the accuracy with which they can help advertisers and marketers understand who they're getting," said Arvind Bhatia, an analyst with Sterne Agee Financial Services. "On Facebook, your information is authentic; they are able to basically make the ads, and your experience, more relevant. I think that is unique. It's unprecedented and the reach is unparalleled."

MUST WATCH

JUST WATCHED

Explain it to me: IPOs

MUST WATCH

JUST WATCHED

Astonishing rise of Facebook

MUST WATCH

Astonishing rise of Facebook03:36

In documents filed in relation to its stock offering, Facebook says that about 85% of its revenue comes from advertising. The other 15% comes from payments made within apps that run on the site (a head-turning 12% is from a single source -- Zynga, makers of social games such as "FarmVille.")

As Bhatia suggests, Facebook's unprecedented advertising advantage is built upon the service it provides. As users interact with the site, they gradually build a fuller and fuller picture of themselves. That, in turn, lets Facebook sell advertisers on its ability to put their product in front of the people most likely to be interested.

For example, say a woman who has listed her hometown as New Orleans changes her relationship status from "single" to "engaged." Facebook suddenly has a hot prospect to offer up to a bridal retailer or caterer in the Big Easy. To dig deeper, if she lists her MBA from Loyola and has "liked" pages for, say, Saks Fifth Avenue and Mercedes Benz, you get a fuller picture of how much she might be willing to spend.

"With a reported 901 million members, Facebook is a great test bed for understanding consumers and their purchasing interests," said Jan Rezab, CEO of Socialbakers, a social-media analytics firm. "Before Facebook, marketers relied on online surveys or focus groups to determine customer interest. Now, they can reach the customer directly on their Facebook page."

Facebook doesn't publicly give away the details of how its system works.But as it has begun wooing potential investors, the company has been more willing to talk about its advertising approach.

According to research from Pew, the average Facebook user has 229 friends.When that user likes a product or company's ad, it serves as an endorsement to those friends from someone they know and, presumably, trust.

"When I raise my hand and say, I like Einstein (Bros.) bagels, and then one of my friends sees that ad, they're going to see my name in that ad," Rose said. Through Facebook's partnership with the media-research firm Nielsen, "We found that when my friend's name is in an ad, I'm over 60% more likely to remember the ad, and I'm over four times more likely to purchase the product," he said.

"This is word of mouth. This is word of mouth at scale. This is what, as marketers, we've always been trying to bottle up and find a way to take advantage of. And the social Web is finally allowing us to do that."

In his 2010 book, "The Facebook Effect," David Kirkpatrick recounts chief operating officer Sheryl Sandberg's arrival in 2008, when she sharpened the company's focus on what would become the current advertising model. CEO Mark Zuckerberg, meanwhile, remained focused on growing the site and improving user experience -- a focus he reportedly maintains to this day.

JUST WATCHED

Should you 'like' the Facebook stock?

MUST WATCH

JUST WATCHED

MYB: Facebook looks to diversify board

MUST WATCH

MYB: Facebook looks to diversify board02:39

Kirkpatrick writes of the level of detail a Facebook ad can reach:

"Anybody can pick through endless combinations on Facebook's self-service ad page," he wrote, referring to the tool advertisers use to target their ads. "You can show your ad only to married women aged 35 and up who live in northern Ohio. Or display an ad only to employees of one company in a certain city on a certain day. (Employers aiming to cherry-pick people from a competitor do this all the time).

"Customers for Facebook's more expensive engagement ads can select from even more detailed choices -- women who are parents, talk about diapers, listen to Coldplay and live in cities, for example."

In its Wall Street filing, Facebook listed its Average Revenue Per User at $1.21 per quarter, or $4.84 a year. That's less than rivals like Google and Yahoo and miniscule compared to companies with more traditional business models, like wireless providers and cable companies.

But, as Rose says, it's all about scale for a company that will likely reach 1 billion user accounts by the end of the year.

Not that the model hasn't made some folks antsy. Time and again, tweaks to Facebook's privacy settings have prompted user backlash, occasionally to the point that the site has reversed or modified those changes.

According to a recent Associated Press/CNBC poll, three out of five users say they have little or no faith that the company will protect their personal information. Half of those who use the site daily say they wouldn't make a purchase through it and 57% of all users claimed they never click on ads or other sponsored content.

On a page about its advertising approach, Facebook makes it clear that it never sells user data, saying that "if you don't feel like you're in control of who sees what you share, you probably won't use Facebook as much, and you'll share less with your friends."

Facebook officials also emphasize that while advertisers can market to specific users, they don't receive the data that was used to make the selection and never know the actual names of the people they've reached. Facebook's policy is to not actually look at user data except to check whether someone is violating the site's terms of service.

Doubling down on user satisfaction is the most important thing Facebook can do, Bhatia said, even if it occasionally means passing up chances to max out the amount it could earn on the data users provide.

"For them, the user experience does come first and I think that's the right strategy for the long term," he said. "Along the way, putting the user experience first makes a lot of longer-term business sense."

As an analyst, Bhatia is bullish on Facebook, leading the pack with an early "buy" rating at the beginning of this month. With Facebook reportedly looking at expanding into China and at monetizing its mobile app (an untapped resource even though the majority of time on the site is now spent on mobile devices) he expects its data-driven model to keep making money well into the future.

"Facebook is going to become just like search, [which] disrupted online advertising," he said. "What Google did eight years ago -- that is what Facebook is doing now. The reach is unparalleled and they're just scratching the surface."